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All in the Fund Family

Is sticking with funds in the same family a bad idea?

With more than 7,000 mutual funds floating around, it can be tough to sort through the vast, underperforming majority to find a few decent ones. When you do find a good, high-performing fund, it's tempting to want to look within the same fund family for another winner. If your managers stomped the market with their large-cap value fund, you might assume that their small-cap growth fund is a great pick, too. But is sticking to one or two fund families really a winning move?

Family obligationsIn truth, a fund family's members are no less diverse than your own family. It's important to consider whether a company runs all its funds according to one overriding philosophy. For example, all of Dodge & Cox's funds will be managed similarly, by the same pool of team members, all using the firm's value investment process.

In contrast, a firm like Fidelity generally lacks a comprehensive investment philosophy. It offers dozens of different mutual funds, spanning all corners of the market, typically with less manager overlap between funds. As a result, Fidelity's funds will differ from one another more greatly than Dodge & Cox's.

Think back to your freshman-year investing course, and try to remember the whole point of constructing a portfolio. Ah, yes: diversification. That whole "correlation" concept probably came up, too. When populating a portfolio with stocks or funds, we want the lowest possible correlation. That way, when one stock or fund does poorly, a different stock or fund will perform well, offsetting those losses.

The same thinking largely applies to fund families. If a fund company that manages all of its funds according to the same process has one or two poorly performing funds, the odds suggest that all of their funds will have trouble meeting their benchmarks -- bad news for investors. In most cases, I think it makes sense to look across fund families for your investments, unless you can find a few great funds from a company as diverse in structure as Fidelity.

Less is moreRemember, filling a mutual fund portfolio with 15 or 20 different funds is an exercise in redundancy. With so many funds, you could essentially have managers buying and selling stocks such as Cisco (NASDAQ:CSCO), Staples (NASDAQ:SPLS), and Charter Communications (NASDAQ:CHTR) to and from each other, leaving you with nothing but transaction fees. You should aim for somewhere between five and eight funds -- no more, no less. And that small number makes diversifying across fund families even more important.

Exceptions to the ruleThat said, I think there are times where you can safely hold a few funds from the same family. Just make sure you cap related funds at two -- three at the very most. If you find a fund family you absolutely love, managed according to an overall firm philosophy, try to get two funds in different market segments -- a domestic large-cap fund and an international fund, for instance, or a bond fund and an equity fund. Otherwise, you risk duplicating your holdings.

Certain fund families offer several quality mutual funds with sufficient differentiation and lack of manager overlap. In these cases, you could safely hold two or more funds without worrying about underdiversification. Vanguard is probably the best example here, as is American Funds, to a lesser degree.

Whether you choose to go with one fund family or 10 different ones, remember that your most important step is digging beyond the family name for an in-depth look at each individual fund. Look for funds with long-tenured management teams, consistent investment philosophies, and solid long-term performance. If you can avoid blind reliance on a company's name or reputation, you'll be well on your way to investment success.

To find funds with the best chance of outperforming the market, check out Shannon Zimmerman'sMotley Fool Champion Funds newsletter free for 30 days.

Fool contributor Amanda Kish lives in Rochester, N.Y., and does not own shares of any of the companies or funds mentioned herein. The Fool's disclosure policy inherited its mother's transparency, its father's fiscal responsibility, and its crazy uncle's sense of humor.